On a "Stable Disequilibrium", Global Housing and Comparing Diets-Part I !

On a "Stable Disequilibrium", Global Housing and Comparing Diets-Part I !

The well known fund manager PIMCO holds an annual “secular forum” where they invite  a group of  distinguished outside guests which include investors, economists and policy makers, to discuss  the outlook for the global economy and markets over the next three to five years and  their implications for investment portfolios. The basic theme this year was that of the “new normal”  (i.e. low growth in the developed world) morphing into a “stable disequilibrium” entailing  very diverse outcomes for  the global economy. http://www.pimco.com/EN/Insights/Pages/Secular-Outlook-El-Erian-2013.aspx. To summarise:

-We are witnessing the emergence of a  “three-speed world”  (as described by Christine Lagarde of the IMF), with the fast-growing emerging countries (led by China)  continuing to be the engine of growth for the global economy, while  Europe and Japan  act as  a drag on  global  growth,  and the U.S. economy  slowly healing in the middle.

-Hyperactive central banks have pursued unconventional policies to support growth and counter financial instability, providing investors with a down payment on future growth and returns by elevating market prices. If this growth fails to materialize, investors are in for a rude awakening .

-Central bank actions have helped the banking sector ( in the U.S.) clean-up balance sheets, raise capital and realign their business models,  while in Europe this process still lies ahead for most of the banks, though the ECB (importantly) has removed the tail risk.

-Large companies have remained cautious and focussed on cost control, while small companies have struggled to get access to credit, maintain revenue growth, profitability and balance sheet strength.

-Households in the emerging world have benefited enormously from the high growth rates and millions have been pulled out of poverty (particularly in China).  However,  their counterparts in the developed world have fared less well, with only the rich and educated classes experiencing income growth while the middle-class and the lower-income households have struggled with the lack of jobs and dwindling savings.

-While the current situation may feel somewhat stable, the potential for significant turbulence remains (i.e. “stable disequilibrium”) with two possible eventual outcomes: (i) a slowly healing developed world and political renewal  leading to  high sustainable and inclusive growth which can accommodate safe deleveraging in the West and lessen systemic risk in the emerging world; or (ii) even lower growth  leading to debt traps, financial instability and social tensions.  In the interim, the slow growing economies facing an increase risk of “zombification”.

-Growth is critical  to prevent adverse outcomes – for the slow growing economies to overcome their current malaise,  as well  for the fast growing economies to manage their rebalancing efforts.  Higher growth  would also benefit  investors by  validating  currently elevated  market prices and allow them to avoid deep haircuts on their portfolios in a variety of forms (inflation, financial repression, debt restructuring).

-Countries which are closest to reaching this “T” junction between two very contrasting outcomes are in peripheral Europe with their dismal growth, high unemployment and debt problems, followed by Japan which has employed a historical high-risk/high-return strategy, then by France, India and the U.K., and finally the U.S., Brazil, China and Germany.

-Growth models across countries need to evolve – in the developed world, countries need to revive their engines of job and income generation – while China needs to transform its economy from export-led to consumption-led growth.

-Central banks around the world  will be compelled  to follow the Fed in terms of more  aggressive the creative policies  targeting jobs and growth. These could range from supporting  SMEs, buying a broader variety  of assets, and acting more like fiscal (rather than purely monetary) agents. This will continue to be beneficial to markets, though the process  will not be smooth as the polices  are likely to be of a “stop-and-go” nature (particularly in Europe).

-Unless there is a growth renaissance, haircuts on investor capital will increase over the next 3 to 5 years in a variety of forms like inflation, currency depreciation and debt restructuring. Financial repression is set  to continue  and parts of Europe are likely to see more debt restructurings and confiscations.

-Social issues will play an increasingly important role in determining the medium-term outlook, particularly in the West.  While well-developed welfare systems and initial high levels of wealth have allowed some European countries to withstand the high levels of unemployment and collapse in GDPs, discontent against incumbent parties is rising and Europe  faces  crucial elections this year (Germany) and the next  (European parliament).

-While the macro picture has embedded in it several game-changing risk factors, sector stories like the shale gas revolution, digitalization and 3-D printing provide exciting investable opportunities which can be transformational.

Macro outlook:

-In Europe, the collapse of the single currency remains a possibility but a less likely one – while the growing risk of “zombification” coupled with debt restructurings remain a threat.

-The U.S. will continue to heal but at an anaemic pace of about 2%, with growing concerns about the negative structural impact on potential long-term growth.

-Japan, after an initial growth surge,  will face challenges about structural reform to make it sustainable and  a growing backlash from the global community about its policies.

-China will maintain an average growth rate of 6-7.5%, with a gradual  rebalancing of the economy and the financial system.

-Inflation is a close call – with  a supply shock, lower growth potential and currency debasements increasing the risk while the large output gap, deleveraging, weak demand and fiscal contraction diminishing the risk.

Investment implications:

-With asset prices being disconnected from fundamentals, and absent an upward move in growth, it is advisable to reduce exposure (and take gains) with the riskiest parts of the portfolio – whether sovereign or corporate.

-Look for specific global sectoral opportunities outside the central bank supported asset space and resist the temptation to follow financial pundits who advocate buying expensive assets which are “relatively” cheap to other expensive assets.

-Keep liquidity, as  retaining  the optionality is important in a world which could face adverse outcomes. For example, the European banks will eventually be forced to go through a process of good asset sales and capital raising.

-Diversification, while necessary, may not be sufficient to protect against adverse tail risk events which need to be hedged.

-Assets  may hit serious air-pockets going forward if the future growth and returns embedded in  prices are not realised – so a focus on alpha returns (asset specific) rather than beta (macro) would be more appropriate.

A comprehensive analysis which lays out a useful framework to help position and rebalance portfolios. Central bank activism has been, and is likely to continue to be, the key factor driving global markets for the next 12-18 months. With the Fed leading the charge in terms of innovative and aggressive policies, it is not surprising that the U.S. markets have  significantly outperformed Europe and EM over the last 12 months. However, this is likely to change going forward as the U.S.  delivers less growth than currently anticipated, with the ongoing fiscal contraction and the possibility of tapering the QE program. In contrast, Europe is likely to see a more active role played by the ECB in promoting growth and jobs which should lead to superior market performance, particularly given the undervaluation of markets.  EM central banks are also likely to implement more aggressive  stimulative policies (particularly in China & India) to keep growth ticking while they implement  a more domestic focussed rebalancing of their economies.

In terms of  portfolio specifics, it would be prudent to gradually reduce the overall weighting to the U.S. market, and increase weightings to Europe and EM and Japan. Peripheral European markets, China and  India offer particularly attractive entry levels. The main risk going forward to markets continues to be the unintended consequences of tightening monetary policies by global central banks – an event currently expected  to be mid-2015 at the earliest, until when the Fed is expected to keep its zero interest rate policy.

Global Housing index:

The Economist published their quarterly global housing index update and the table is presented below. It should be of no surprise to see Hong Kong at the top of the list for all three categories- having experienced the highest price rise over the last year (24.5%!) , the highest rise since Q4 2007 (109.4%!) and the most expensive in terms of current prices to the long term averages of rents. India is number two on the list in terms of price increases since Q4 2007 (88%) with Singapore third at 24.8%. As is usually the case in all  markets (eventually!), one can expect a reversal of the rankings over the coming years.

  

Comparing  Diets-Part I:

To follow-up on my earlier serialisation of a landmark research note written by Nathan Pritkin in 1976, arguing that a high  carbohydrate diet/ low animal protein resulted in a lower incidence of the three major chronic diseases (heart disease, cancer and diabetes) in  a variety  of indigenous cultures around and world and medical studies  conducted in various U.S. universities, I present a serialisation of an article written by a noted proponent of a plant-based diet  - Dr. John McDougall -  which compares the diets (and incidence of various diseases) of different cultures around the world, incorporating both low carb/high animal protein and high carb/low animal protein diets, before the advent of the globalization of the western diet.

-A study conducted in the 1920s  on the normadic Kirghiz and Dzungarian plainsmen in  Central Asia, showed that they consumed   large quantities of organic pasture raised fermented mare’s milk and meat per day.   These nomads experienced a high incidence of obesity, premature atherosclerosis, contracted kidney, gout, nervous disorders  and  apoplexy. Even modern day Mongols, who are still largely nomadic and consume a diet rich in organic pasture raised animal foods , have high rates of obesity, cardiovascular  disease and cancer

-A study conducted in 1916, observed that native Javanese who consumed their staple diet which was mainly vegetarian with rice as the staple, had very low cholesterol levels and incidence of heart disease. However, the  their Javanese counterparts who worked on Dutch passenger ships and consumed the traditional cholesterol and fat laden diet, had  much higher cholesterol levels and incidence of heart disease.

-The first ever feeding experiment in relation to cholesterol  levels was conducted in 1922, showed that a small group of Javanese natives experienced a 40mg increase in cholesterol levels when they were shifted from their traditional diet to a 6-week regimen high in meat, butter and eggs.

-During the same period, a  review of 10 years of hospital admissions in Indonesian hospitals, with thousands of cases, showed only 5 cases of gallbladder disease and 1 surgery and zero cases of arterial  blood clotting.  Earlier doctors practicing in Indonesia also reported the extreme rarity of cancer.

To be continued!